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January 11, 2013

Guaranteed Income? Not Without Risk: GAO

Report examines differences, similarities between annuities

For a while now, guaranteed income has been a defining factor in the annuity market. A report released in December by the Government Accountability Office found that these popular benefits aren’t without risk, though.

The report examined variable annuities with guaranteed lifetime withdrawal benefits (VA/GLWB) and contingent deferred annuities (CDA), as well as the regulations that cover each.

A CDA gives an investor guaranteed lifetime income payments if his or her investment account is exhausted, the report said. Unlike an annuity, the assets in the CDA are typically held in a brokerage or investment advisory account, rather than by the insurer. Payment is contingent on the assets falling to zero, according to the report. Of the products reviewed by the report, fees on CDAs were based on a set percentage of the assets per year, and didn’t include fees paid for the underlying assets that the CDAs cover.

There are some other structural differences between CDAs and the variable annuities to which guaranteed benefits are attached. With an annuity, investors can annuitize an account balance in the future, something they can’t do with CDAs. Investors would have to sell the assets covered by the CDA and use the proceeds to purchase a separate annuity.

Furthermore, investors can elect death benefits with a variable annuity, a feature not available with CDAs.

VA/GLWBs and CDAs both have three phases, according to the report: the accumulation phase, withdrawal phase and insured phase. When investors withdraw all the assets they accumulate, they reach the insured phase, when the guaranteed benefit kicks in. With both products, once the insured phase begins, investors generally can’t change the schedule or amount they’ve established, according to the report.

VA/GLWBs and CDAs both offer investors the ability to withdraw assets at any time, according to the report, but with CDAs, investors can apply guarantees to assets they already own, such as in an IRA, instead of selling the assets and purchasing a new annuity.

The report stressed that both products are complex and not suited for every investor. Those who purchase a CDA or VA/GLWB without understanding or guidance from a professional run the risk of investing an inappropriate amount. “Insurers with whom we spoke said that VA/GLWBs and CDAs are generally attractive to middle-income consumers who want more control and flexibility over the investments they are relying on to provide retirement income,” the report stated. Another insurer consulted for the report said investors with approximately $500,000 in retirement assets invested about 20% of that in variable annuities or CDAs.

The report also pointed out that many consumers are probably unable to adequately compare products between different insurers.

Even taking withdrawals can be precarious if investors take the wrong amount at the wrong time. They risk losing their guarantee altogether or incurring additional fees, the report stated.

And, of course, there’s always the risk that by the time investors need to claim their guarantees, the insurer may not be around to provide them anymore. The report referred to officials from the National Organization for Life and Health Guaranty Associations who said that promises made with guaranteed benefits on annuities are generally covered by state guaranty funds, but CDAs don’t come with the same promises.

VA/GLWBs are considered to be securities and insurance products, the report noted, and thus are covered by state insurance commissions and federal regulators. The report said that being relatively new, CDAs’ analysis as securities is less developed. CDAs are covered by the National Association of Insurance Commissioners, which has deemed them to be insurance products; however, the report cited SEC officials who said that CDAs currently being offered have been registered as securities. Furthermore, the SEC hasn’t issued written guidance regarding CDAs.

The NAIC issued in 2011 a model disclosure regulation to help both insurers and consumers understand annuity products. The model disclosure explains to consumers that annuity products are long-term investments and explains basic features, benefits and fees. It provides guidance for insurers to develop suitable illustrations for consumers.

According to NAIC, states’ adoption of suitability rules varies significantly. This is important for CDA owners because disclosure and suitability regulations may depend on individual states rather than federal rules, according to the report.

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